Taxless in Seattle?

Washington State votes on an income-tax referendum.

Ethan Epstein

September 27, 2010, Vol. 16, No. 02

Camas, Washington

Readers of Fortune magazine opened the September 6 issue to find a glossy eight-page insert advertising business opportunities in Washington state. In addition to the state’s proximity to Asia, its strength in the technology sector, and its inexpensive electricity, the ad stressed another factor that makes Washington an attractive place to do business: its lack of an income tax. Yet a referendum this Election Day could change all that.

Initiative 1098, as it’s known, would see Washington surrender its distinction as one of only seven states without an income tax. It would tax gross income above $200,000 for single earners, and $400,000 for joint filers, at a rate of 5 percent. Gross income above $500,000 for singles and $1 million for joint filers would be taxed at 9 percent. The state estimates that the initiative, which includes a modest reduction in property and business and operating taxes, would raise $11 billion over the next five years. Not coincidentally, Washington’s state government is projected to run a $3 billion deficit this year.

In spite of the state government’s predilection for writing in red ink, Washington has fared relatively well in the great recession. Major corporations like Microsoft, Boeing, and Intel have a big presence here and drive job growth. The unemployment rate is 8.9 percent—hardly ideal, but below the national average (and far below the 12.3 percent in nearby California). Per capita income is ranked 13th in the country and is considerably higher than in the neighboring states of Oregon, Idaho, and Montana. Democratic governor Chris Gregoire uses the state’s lack of an income tax as part of her pitch to businesses considering setting up shop here.

Washington state has traditionally been steadfast in its opposition to income taxes. A 1933 state supreme court ruling classified income as a form of property. Because the state constitution mandates that property be taxed uniformly, the legislature has been prevented from imposing a graduated income tax. (The state supreme court has nullified numerous income tax provisions since the thirties.) Furthermore, Washington voters have rejected constitutional changes to allow for an income tax eight times. In order to circumvent the state’s prohibition on income taxes, Initiative 1098 speaks of an “excise tax on income.” Should it pass, this slippery wording is sure to spark yet another court fight.

Initiative 1098 is being promoted as a tax on the “rich”—an income tax for “only the wealthiest 1.2 percent,” as the promoters’ television ad puts it. Yet opponents argue that 1098 is predicated on a false premise. They say it would harm far more than a narrow and extremely wealthy subset of the population.

Opponents argue that 1098 would do great damage to Washington businesses. Many small businesses report their revenue as income, which would be subject to the new tax. Mike Sotelo and Craig Dawson, leaders in the Washington business community, point out that “almost 70 percent of those earning $200,000—where the income tax first kicks in—are small business owners.”

Don Brunell, the head of the Association of Washington Business, whose 7,000 members range from Boeing and Microsoft to the corner cafe and muffler shop, is a leading voice against the initiative, for the same reason: “This is not a tax on wealthy people. It’s a tax on small business.” Brunell estimates that virtually every business with more than five employees would be negatively affected. People worry that towns like picturesque Camas on the Columbia River, which thrives on a mix of manufacturing, services, and retail, would be hit hard by the new tax.

Supporters of the measure rightly point out that Washington has a woefully regressive tax structure. A recent study from the Institute For Taxation and Economic Policy found that residents earning less than $20,000 a year lose a whopping 17.3 percent of their income to state taxes. Yet 1098 does nothing to alleviate Washington’s high sales tax, the main culprit in this regressive structure. While 1098 does include a modest reduction in state property tax rates, moreover, Brunell notes that, “because the lion’s share of property taxes are local, the average tax bill would only go down about 4 percent.”

Opponents also worry about “taxation creep.” The initiative’s supporters assure Washingtonians that should the measure pass, income tax rates would remain at 5 percent and 9 percent and affect only those with incomes over $200,000. Yet, two years after the new tax took effect, the legislature would be empowered to expand the income tax by a simple majority vote. People look to Connecticut, the most recent state to impose an income tax, and see cause for concern. As the Wall Street Journal reported last month, since the Nutmeg State introduced an income tax in 1991, the top rate has climbed from 4.5 percent to 6.5 percent. The same thing could happen in Washington.

Some big names—with big bank accounts—are bankrolling the effort to impose the tax. Bill Gates Sr., the father of America’s richest man, is spearheading the initiative, and he’s already donated half a million dollars to the cause. The SEIU, with its deep pockets, is also backing the effort. But the other side has financial muscle as well: Seattle venture capitalists like Tom Alberg and Jon Runstad have written $25,000 checks to defeat the measure, and other business leaders are pledging “No On 1098” money as well.

The fight is already fierce. The most recent poll, taken in early August, found a dead heat, with both sides garnering 41 percent support. As money continues pouring into both camps, neither has an easy path to victory.